Peru is Investment Grade: Will Brazil Be Next?

RGE Monitor, Vittoria Saddi

According to Fitch, the upgrades recognize the strong improvement in Peru’s fiscal and external solvency ratios, which now demonstrate a sufficient counterbalance to the country’s key credit weaknesses, including a selective export base as well as political and social risks. Peru’s public finance and external account performance once again exceeded expectations, contributing to a better than anticipated improvement in the sovereign’s financial ratios.

Fiscal responsability, liability management operations, and sizable reserve accumulation in recent years have allowed net repayments of public external debt. As a result, the public sector became a net external creditor in 2007, sooner than initially anticipated. According to Fitch: Peru’s net public external debt (NPXD) to current account receipts (CXR) ratio, a key rating weakness in the past, reached an estimated -22% by the end 2007. If current trends continue, Peru’s net public external creditor position will exceed the ‘BBB’ median by the end of this year. The government’s external debt burden is also mitigated by astute debt re-profiling operations and prepayments, which have reduced the public sector’s external amortizations to less than 1% of GDP per year over the medium term. Other external solvency ratios such as liquidity and external financing needs as a proportion of foreign exchange reserves, also exceed the median of investment grade sovereigns.

Fitch then recognizes that Peru’s key credit weaknesses relative to low investment-grade sovereigns continue to include its poor governance and social indicators. Nevertheless, the continuation of high, broad-based economic growth and a solid fiscal position will sustain the declining trend in both public and external debt burdens over Fitch’s rating horizon, as well as provide the flexibility necessary to target social expenditures toward addressing human development shortcomings. Maintenance of these positive trends should alleviate Peru’s vulnerability to a commodity price shock and entrench the growing consensus for Peru’s macroeconomic framework.

Further strengthening of Peru’s external creditor position as well as a sustained progress toward closing the gap between the country’s per capita income. Finally, substantive progress on structural reforms related to public finances or the labor market could also support an improvement in Peru’s creditworthiness over Fitch’s rating horizon. The fact that Fitch upgraded Peru suggests that Brazil might be upgraded too until year end. The most important question is yet to be answered: Why do rating agencies upgrade countries with highly unequal income distribution? This is important because it is a potential source of social unrest in the future.